Today, we cover common questions about Roth vs. traditional contributions, TSP and solo retirement plan strategies, brokerage accounts for businesses, and balancing investing with paying for medical school. We also talk through how account structure and tax efficiency can quietly make a big difference in long-term wealth building.
Roth vs. Traditional Accounts
“Hi, Dr. Dahle. Thank you for having me. My name is Russell. I’m a general surgery resident from New York. My question is about Roth vs. traditional IRA. Whenever someone discusses this topic with me, they always only reference the level of income as a determining factor of which one you contribute to.
However, in my mind, if you have high income earning potential early on in your career, Roth might still make sense because the time horizon could allow the investments to overcome the upfront tax savings that a traditional IRA provides. I’m wondering what your thoughts are on this and also why no one really talks about time at the same time as the income level thing.”
A Roth IRA can still make sense for a high-income physician, even when they are already in a very high tax bracket. The key issue is not simply your current income level but whether you expect your future tax rate to be higher or lower than it is today. A Roth contribution means paying taxes now in exchange for tax-free growth and withdrawals later. If you expect your tax rate to rise over time, paying taxes now can still be a smart move even if your current income is already substantial.
Most complicated financial decisions ultimately come back to a fairly simple principle of paying taxes at the lowest possible rate. Many investing and retirement account decisions become easier once viewed through that lens. Traditional accounts work best when contributions are deducted at a high tax rate today and withdrawals happen later at a lower tax rate. Roth accounts work best when taxes paid now are lower than the taxes that would otherwise be paid in the future. The challenge is that no one knows future tax rates with certainty, so investors often make educated guesses based on their likely earnings trajectory and retirement situation.
Physicians often overestimate how much of their retirement withdrawals will actually be taxed at their highest marginal bracket. Even high-income retirees typically have income spread across multiple tax brackets. Some retirement income may fill lower brackets first before higher rates apply. Because of that, many doctors benefit from using traditional retirement contributions during peak earning years to capture large deductions now. The decision is less about whether Roth accounts are “good” or “bad” for high earners and more about comparing today’s tax rate with the likely effective tax rate on future withdrawals.
More information here:
Should You Make Roth or Traditional 401(k) Contributions?
Roth vs. Tax-Deferred: The Critical Concept of Filling the Tax Brackets
When You Have Multiple 401(k)s
“Jim, thanks for all the good information and advice that you’ve given me over the years in your blog. My question is about having multiple solo 401(k)s. I have a 401(k) from a former employer that is held at a place that has limited options for my retirement funds. I was wanting to move that 401(k) to a local establishment with wider investment options and low fees. I trust the local place, and it holds the Roth IRAs for me and my wife.
The local establishment’s first thought was to place the rollover in an IRA, but since it’s a sizable 401(k), it would eliminate the Backdoor Roth I do every year due to the pro rata rule. I was an independent contractor for a few years and still have some 1099 income. They thought a full solo 401(k) could be started there and I could transfer my old employer’s 401(k) to that. But I already have a solo 401(k) that I started during my full-time 1099 job that is at Fidelity, and I want to keep those funds there. Can you have two solo 401(k)s for this situation? I could contribute to one of them for my very part-time 1099 income, but I’m not sure as I am a full-time W-2 employee with a new company now and probably maxing out their pre-tax 401(k) contributions.”
Yes, you can legally have multiple solo 401(k)s, but in most cases, there is very little benefit to doing so. The main issue is that all of your 401(k)s still share the same employee contribution limit. For 2026, that limit is $24,500 for those under age 50. Even if you have both a W-2 employer 401(k) and a solo 401(k), you cannot double-count those employee contributions. However, each unrelated 401(k) can still have its own total contribution limit under the 415(c) rules, which means additional employer or after-tax contributions may still be possible depending on the situation.
It is best to avoid unnecessary complexity and simply roll the old employer 401(k) into the existing solo 401(k) rather than opening a second one. Since the questioner still has ongoing 1099 income, they remain eligible to maintain and use their solo 401(k). Rolling the prior employer plan into that account avoids the pro rata problems that would come from moving the money into a traditional IRA and preserves the ability to continue doing annual Backdoor Roth IRA contributions. Investors should not feel pressured to jump through excessive hoops just to preserve the Backdoor Roth. While it is a useful strategy, missing out on one year is not financially catastrophic if the alternative is creating an unnecessarily complicated retirement account structure. Keeping things simple is worth a lot.
Many physicians create more account complexity than they actually need. Having multiple solo 401(k)s usually adds administrative hassle without providing meaningful additional benefits. Investments should generally be viewed as one unified portfolio rather than disconnected buckets. When working with a financial planner, they should be capable of helping you coordinate employer plans, solo 401(k)s, IRAs, and taxable accounts together instead of ignoring “held away” assets. The simpler solution is often the better one, especially when the tax advantages are already fully available through existing accounts.
More information here:
What to Do with Multiple 401(k) Accounts
What to Do After Maxing Out 401(k) and Roth IRA
How to Best Take Profits from Your Business
“Hey, Jim. This is Mike from Philadelphia. I’m an orthodontist. And as a practice owner, I was thinking about how we take profits from the business, and we’re either going to reinvest it in the business or take it as a dividend. Taking it as a dividend, you’re obviously paying taxes on that, and then let’s say investing in the stock market through a taxable brokerage account.
As an alternative to that, could it be advantageous to instead open a business brokerage account and invest into the market that way? I’m thinking this could potentially save on taxes and possibly have some asset protection benefits as well. But I don’t know if I’m missing something or just overthinking or overcomplicating it. I’m just curious to hear your thoughts.”
Opening a business brokerage account inside a medical or dental practice generally does not provide the tax or asset protection advantages many people assume it does. For most physician practices structured as pass-through entities—such as LLCs, partnerships, or S corporations—the profits are taxed personally in the year they are earned, whether the money stays inside the business or not. Simply moving profits into a business brokerage account does not avoid taxes. If a practice earns $100,000 and invests it through a brokerage account owned by the business, the owner is still paying taxes on that income personally for that year.
The situation is somewhat different for C Corporations because the corporation itself pays taxes before distributing dividends to the owner. However, this often creates a double taxation problem. The corporation pays corporate tax rates first, and then the owner pays taxes again on the dividend received personally. For a high-income physician or, in this case, an orthodontist, that combined rate can easily approach or exceed 45% when federal corporate taxes and qualified dividend taxes are added together. Because of that, the recommendation is usually to distribute the profits to the owner and invest personally through taxable brokerage accounts rather than trying to build an investment portfolio inside the business itself.
The asset protection argument is also weaker than many people think. Keeping excess investments inside the business may actually increase risk exposure because those assets remain available to business creditors if the company is sued. The entire point of forming an LLC or corporation is often to separate business liabilities from personal assets. If large investment accounts are left inside the business unnecessarily, those funds may become vulnerable in a business lawsuit or bankruptcy situation. The better approach is usually to pull excess profits out of the business once they are no longer needed for operations and invest personally. If the business does need cash reserves for near-term operations, keeping the funds in safer options, such as money market funds or high-yield business savings accounts, makes more sense than investing them aggressively in stocks.
To learn more from this episode, read the WCI podcast transcript below.
This podcast is sponsored by Bob Bhayani at Protuity. He is an independent provider of disability insurance planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. He specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies. If you need to review your disability insurance coverage or to get this critical insurance in place, contact Bob at whitecoatinvestor.com/protuity today by email [email protected] or by calling (973) 771-9100.
Milestones to Millionaire
#277 — Graduating Residency with a $200,000 Net Worth
Today, we talk with a physician graduating from residency with a $200,000net worth and the financial decisions that helped make it happen. We also discuss lessons from military medicine, along with how consistency, intentional planning, and smart career choices can create momentum early in a physician’s career.
To learn more from this episode, read the Milestones to Millionaire transcript below.
Sponsor: DLP Capital
Financial Boot Camp Podcast
Financial Boot Camp is our new 101 podcast. Whether you need to learn about disability insurance, the best way to negotiate a physician contract, or how to do a Backdoor Roth IRA, the Financial Boot Camp Podcast will cover all the basics. Every Tuesday, we publish an episode of this series that’s designed to get you comfortable with financial terms and concepts that you need to know as you begin your journey to financial freedom. You can also find an episode at the end of every Milestones to Millionaire podcast. This podcast will help get you up to speed and on your way in no time.
Understanding Index Funds
Index funds are built to match the performance of the market instead of trying to outperform it, and that strategy has historically beaten most actively managed funds over long periods of time. Actively managed funds have higher costs because they rely on teams of analysts, research, trading, and management decisions in an attempt to outperform the market. Those expenses directly reduce investor returns. Index funds are much less expensive to run—which is why their expense ratios are often extremely low, sometimes only a few basis points. Over decades of investing, keeping fees low can dramatically increase how much money an investor ultimately keeps. Even a seemingly small 1% fee can reduce long-term wealth by a significant amount because costs compound just like investment returns do.
Broad-based index funds also provide instant diversification by owning hundreds or thousands of companies across the market. Funds that track indexes like the total stock market or the S&P 500 allow investors to own nearly the entire market in a single investment. That means investors will inevitably own both successful and unsuccessful companies, but over time, they’ll capture the overall growth of the market itself. Narrow sector funds or specialty index funds exist as well, but they are much less diversified and carry greater risk. For most investors, broad-based index funds provide a simple, effective strategy that avoids the need to constantly research stocks, predict market movements, or chase performance.
Index funds are also highly tax-efficient because they typically have very low turnover. Since the goal is simply to track an index, there is much less buying and selling happening inside the fund compared to actively managed funds. Lower turnover means fewer taxable capital gains distributions passed on to investors. This becomes especially valuable in taxable brokerage accounts, where taxes can quietly erode returns over time. Index investing also works effectively regardless of portfolio size. Whether someone is investing a few hundred dollars or several million dollars, the same principles still apply. Investors do not necessarily need more complicated strategies simply because they accumulate more wealth. Broad, low-cost index funds remain one of the simplest and most reliable tools for building long-term wealth while minimizing unnecessary costs, taxes, and complexity.
To learn more about understanding index funds, read the Financial Boot Camp transcript below.
WCI Podcast Transcript
Transcription – WCI – 474
INTRODUCTION
This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We’ve been helping doctors and other high-income professionals stop doing dumb things with their money since 2011.
Dr. Jim Dahle:
Welcome to the White Coat Investor podcast.
This podcast is sponsored by Bob Bhayani of Protuity. He is an independent provider of disability insurance and planning solutions to the medical community in every state and a long-time White Coat Investor sponsor. Bob specializes in working with residents and fellows early in their careers to set up sound financial and insurance strategies.
If you need to review your disability insurance coverage or to get this critical insurance in place, contact Bob at www.whitecoatinvestor.com/protuity. You can email [email protected], or you can also call (973) 771-9100.
All right. We love making this podcast for you. We hope it is enjoyable to you. We’re grateful for what you do in your daily lives. If you had a rough day today, I’m sorry, number one. Number two, thanks for doing it. It’s a hard job you have. If you’re coming home from a bad shift or a patient death or just given some bad news or just being chewed out by somebody, this too shall pass. The world is grateful for your contribution to it.
TSP UPDATE FROM EPISODE 466
Dr. Jim Dahle:
Okay. Let’s get right into your questions here. The first one is someone that writes in with some additional information. In podcast 466, we talked to someone who’s looking to isolate basis in their thrift savings plan. Combat zone tax exempt contributions get lumped in with your tax deferred money in the TSP.
And so, it makes it a little bit tricky to get that money into a Roth account so the earnings will be tax-free as well. Otherwise, if you just leave it where it is, the earnings will be tax deferred. You won’t pay tax on the principal when you take it out, but you will on the earnings. So best to get that into a Roth account by doing a Roth conversion of some kind on it.
Anyway, this active duty person, it’s an army doc, writes in and says, “I just solved this issue for myself with my similar situation. Your answer would work fine.” I told them basically to roll it all out or almost all of it out to an IRA, and then just roll back the tax deferred money, leaving the tax exempt money in the traditional IRA, which can then be converted to a Roth IRA.
But there is another option, especially if he wants his Roth to stay in the TSP. He says “He can combine the accounts by calling the thrift line, that’s 877-968-3778, and requesting they send form TSP 65 request to combine civilian and uniform services TSP accounts.”
If you remember this particular questioner had been on active duty and now is working as a civilian and had two different TSP accounts. So you fill this form out and upload it to the website. That’ll roll over the uniform services TSP, both the traditional and Roth into a civilian TSP, but they will not accept the combat zone tax exempt contributions, nor will they go to the civilian TSP Roth. It just stays behind in the uniform services TSP traditional.
He’ll then be left with a larger civilian TSP and a smaller uniform services TSP that only has tax exempt traditional contributions. Then he just does a Roth conversion of his entire uniform services TSP account, which now only consists of tax exempt contributions, and nothing bad will happen in the civilian account. The process makes it very explicit what you’re doing.
He does note that there’s one, what he calls a baloney item. They will do the Roth conversion for all of the tax exempt money except for $500. That’s going to remain tax exempt traditional for what they call a correction buffer or operational efficiency. I guess my method works similarly in that you have to leave a little bit of money behind, or the account will be closed behind you. Apparently, there’s no way you can convert every single dime of those tax exempt contributions, but you can get most of it done.
All right. Speaking of Roth accounts and traditional accounts, let’s take this question off the Speak Pipe.
ROTH VS. TRADITIONAL ACCOUNTS
Russell:
Hi, Dr. Dahle. Thank you for having me. My name is Russell. I’m a general surgery resident from New York. My question is about Roth versus traditional IRA. Whenever someone discusses this topic with me, they always only reference the level of income as a determining factor of which one you contribute to.
However, in my mind, if you have high income earning potential early on in your career, Roth might still make sense because the time horizon could allow the investments to overcome the upfront tax savings that a traditional IRA provides. I’m wondering what your thoughts are on this and also why no one really talks about time at the same time as the income level thing.
Dr. Jim Dahle:
Great question. This is the most complicated question in personal finance and investing, whether to make a Roth contribution or whether to make a Roth conversion. It’s complicated. There’s a lot of factors that go into it. The main factor is that you want to pay taxes at the lowest rate possible, not necessarily the lowest tax bill, but the lowest tax rate.
If you are in a place in your life where you can pay a very low tax rate, it probably makes sense to make Roth contributions, to do Roth conversions, et cetera. If you’re in your peak earnings years, oftentimes it doesn’t because you may be in a lower tax bracket in retirement. Better to take the tax break now and pay taxes later.
That’s the main factor, but there’s tons of other factors that go into whether to do Roth or traditional contributions, including things like who’s going to spend the money. Maybe it won’t be you. Maybe it’ll be a charity. If it’s charity, you definitely want to use a tax-deferred contribution because it’s tax-free money to the charity anyway. Similar situation, if it’s going to one of your heirs in a low tax bracket.
Sometimes people make traditional contributions even though they’re not necessarily in a high tax bracket because they’re trying to minimize their adjusted gross income so they can minimize their IDR student loan payments. And maybe the break they’re getting on their student loans, the additional public service loan forgiveness they’re going to get from that is worth paying a little bit of extra money in taxes on this money.
So lots of different exceptions to it. It’s a very complicated situation and anybody that tells you it’s just all about income just hasn’t delved into this enough. There’s a lot of factors that go into it. Probably the best post on the website to check it out. If you go to the website and you just search “Roth contributions”, you’ll get my latest on this decision and how complicated it is and what the right thing to do is.
But mostly I want to encourage you to not beat yourself up about it. The truth is a Roth contribution is a good thing. A traditional or tax deferred contribution is a good thing. At times one will be significantly better than the other and sometimes it’ll be obvious which one of those two is. But the less obvious it is, the less it probably matters in the long run.
So what’s really important is how much money you’re putting toward wealth building activities like paying off debt or making Roth contributions or making tax deferred contributions, not exactly where that money goes. So, don’t beat up about it too much.
QUOTE OF THE DAY
Dr. Jim Dahle:
All right. A quote of the day today comes from Warren Buffett. He said, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” And don’t forget that investing is a long-term game and sometimes you’re not necessarily investing for you.
INVESTING AS A FOREIGNER
Dr. Jim Dahle:
Our next question comes in via email. It says, “I’m an incoming first year med student, an international student from Myanmar. And since getting my acceptance offer, I started reading your White Coat Investor’s Guide for Students.
My foreigner status makes me ineligible for many of the government loans and forgiveness programs you describe, but I’m still greatly interested in the content you produce. I recently got my social security number and have $16,000 in a high yield savings account paying over 4%. If I can set aside $2,000, do you recommend I invest in any index funds? Do you have any recommendations, or is it better to keep it in the high yield savings account? I greatly appreciate any advice you can provide.”
I told him I’d leave it in the high yield savings account. Use it to pay for medical school rather than investing it in stocks. You can do that after you finish your school and your training. This is the time to spend money investing in your future earning ability, not the time to save and invest in the stock market.
If you want to earn more on your money in a safe way, move it to Vanguard, put it in the federal money market fund. It was paying a little, at the time I got this question, it was paying a little bit more than this high yield savings account was. At times, the high yield savings accounts pay a little bit more.
The bottom line is that if you don’t use this for school, you’re probably taking out 7% or 8% loans. If you can earn 4% or 5%, maybe only 3.5% by the time you guys hear this, if that’s all you can earn in a risk-free way, then it makes sense to use that money to not take out a 7% or 8% loan, unless you think there’s a good chance you’re going to get loan forgiveness for that money.
This particular person doesn’t sound like they’re going to be eligible for loan forgiveness. Sounds like we’re talking about private loans for them. All the more reason to use this cash to pay for school. That’s a great use of money. You don’t have to feel like you have to invest in an 8% student loan. That’s a tall order of business.
The One Big Beautiful Bill Act passed in 2025. It changed the landscape for medical student borrowing. Federal student loans are now capped at $50,000 per year, $200,000 total for medical and dental students, which means many students will need private loans to cover a significant portion of their total education costs.
We just launched a new resource to make this easier. You’ll find vetted private student loan companies, plus two bonuses you won’t get anywhere else. You’ll get cash back from some of the lenders themselves. You take out a loan, and they give you some cash.
All of them, if you get a loan through our links, you’ll get free access to our flagship Fire Your Financial Advisor course, the student version that you can upgrade later if you wish, which is our best-selling course for medical students just starting their financial journey. So, check out two or three lenders on the list. Go with the one offering the lowest interest rate and the best terms. You can find that list at whitecoatinvestor.com/loan.
All right, the next question comes from Andy.
HAVING MULTIPLE SOLO 401(k)s
Andy:
Jim, thanks for all the good information and advice that you’ve given me over the years in your blog. My question is about having multiple solo 401(k)s. I have a 401(k) from a former employer that is held at a place that has limited options for my retirement funds. I was wanting to move that 401(k) to a local establishment with wider investment options and low fees. I trust the local place and it holds the Roth IRAs for me and my wife.
The local establishment first thought was to place the rollover in an IRA, but since it’s a sizable 401(k), it would eliminate the backdoor Roth I do every year due to the pro rata rule. I was an independent contractor for a few years and still have some 1099 income. So they thought a full solo 401(k) could be started there and I transferred my old employer’s 401(k) to that. But I already have a solo 401(k) that I started during my full-time 1099 job that is at Fidelity and I want to keep those funds there.
Can you have two solo 401(k)s for this situation? I could contribute to one of them for my very part-time 1099 income, but I’m sure as I am a full-time W-2 employee with a new company now and probably maxing out their pre-tax 401(k) contributions. Thank you.
Dr. Jim Dahle:
Okay, a few comments. First of all, you’re allowed to be a White Coat Investor even if you don’t do a backdoor Roth IRA every year. You don’t have to do incredible gymnastics in order to do that. It’s not a huge contribution. You can probably still do a spousal one if you want. It’s not the end of the world if you invest in a taxable instead of a backdoor Roth IRA. So don’t feel like you got to do anything too crazy just to be able to do that every year.
But that said, what would I do in this situation? I’d just roll the employer’s 401(k) into your solo 401(k) that you already have. You’re still eligible for it. You’re still earning 1099 money, i.e. you’re still self-employed, i.e. you still have a business and that business can have a solo 401(k).
Now, remember when you have an employer 401(k) and a solo 401(k) that they share the employee contribution. For someone under 50, that’s $24,500 in 2026. They share that. But the total contribution to the account, the 415(c) limit, the $72,000 limit, they each get their own. So you can make contributions to two different 401(k)s during the year and have two separate 415(c) limits.
Now, you might have to make employer contributions to your solo 401(k) or after-tax employee contributions, a.k.a mega backdoor Roth IRA contributions to that solo 401(k) if you’ve used your entire employee contribution in the employer’s ERISA 401(k). But you can do that.
But as far as rolling money in, if you’ve got the solo 401(k), it almost surely allows you to roll money into it. So, I don’t know why you wouldn’t roll money into it. Why you need to start a new one, I have no idea unless you want this guy to manage it. I never really understood this concept of investment management where you have some professional manage some of your money, but you manage some of your money. This doesn’t make any sense to me.
If you’re competent to manage your own investments, half of your own investments, you’re competent to manage all of your investments. If you’re not competent to manage half of your investments, why isn’t that guy being hired to manage those as well? I don’t know if people are trying to save AUM fees or what, or part of the issue might be that a lot of financial planners aren’t set up to deal with assets held away in a good way. And oftentimes, that’s your 401(k) is, your 403(b) or your 457(b) or whatever.
And in those situations, those financial planners, those financial advisors need to get on the ball. They need to figure out a way to deal with held-away assets. And what we decided to do at White Coat Planning is to simply have the planner go in basically with you and show you exactly what trades to make in there so that all the money is managed as one big account. And I think that’s the smart way to do it rather than saying, “All right, you do the 401(k), we’re just going to do the IRA and your taxable account.” That’s goofy to me. If your planner hasn’t figured out how to do that, maybe you ought to consider getting a new financial planner.
But that’s the solution I would do. I wouldn’t have two solo 401(k)s. That’s answering the question you should have asked, which is what should you do? The question you asked is, can you have multiple solo 401(k)s? And I think the answer is yes, you can. They share the same contribution limit. I don’t see a big advantage to having multiple solo 401(k)s. I think it adds complexity to your life that you don’t need or want.
But can you? Yes, you can. You are allowed to do so. If you go through the IRS regulations, your business is allowed to have, I guess you could have six 401(k)s if you wanted to. But they’re all sharing the contribution limit. So there’s no real advantage to having more than one.
All right. Our next question comes from Mike.
HOW TO BEST TAKE PROFITS FROM YOUR PRACTICE
Mike:
Hey, Jim. This is Mike from Philadelphia. I’m an orthodontist. And as a practice owner, I was thinking about how we take profits from the business, and we’re either going to reinvest it in the business or take it as a dividend. Taking it as a dividend, you’re obviously paying taxes on that. And then let’s say investing in the stock market through a taxable brokerage account.
As an alternative to that, could it be advantageous to instead open a business brokerage account and invest into the market that way? I’m thinking this could potentially save on taxes and possibly have some asset protection benefits as well. But I don’t know if I’m missing something or just overthinking, overcomplicating it. I’m just curious to hear your thoughts. Thanks for all you do. Have a great day.
Dr. Jim Dahle:
Okay. Great question, Mike. You are definitely overcomplicating things. And no, there probably is not an asset protection benefit. And no, there’s probably not a tax benefit to answer your question. But we got to dive into more details. What you did not tell me is what the practice business entity is. I don’t know if this is a sole proprietorship or a partnership or an S corporation, a.k.a a corporation that has made an S election or a C corporation, or maybe it’s an LLC filing as a sole provider partnership, S corp or C corp.
I don’t know what your business entity structure is, but you do. And so, I guess I have to answer the question, no matter what the entity structure is. Most practices are some sort of a pass-through entity. Most of them are either an LLC filing as a sole proprietorship or partnership, or they are an S corporation or an LLC filing as an S corporation. Those are pass-through entities. Whatever profits the business makes, you have to pay taxes on them in the year you made them.
Just because you set up a business brokerage account for some bizarre reason, I can’t figure out quite why you’d want to do that. Just because you set that up doesn’t mean you don’t pay taxes on those profits. So you still would. If you reinvest $100,000 of your profits into this business brokerage account, guess what? You’re still paying taxes personally on those profits this year.
Now, if it’s a C corporation, the taxation works differently. A C corporation is not a pass-through entity. It pays taxes at its own level. If it has profits, it pays taxes on it. And then when it distributes a dividend, that’s a deduction to the C corporation. And of course, the dividend is taxable to you, hopefully, qualified dividend rates, but maybe not.
But most people aren’t running a C corporation for their medical or dental or orthodontic practice. Just not running a C corp for it. If you are, then you could consider doing this, but the truth is you’re going to pay tax. You’re going to get double tax, really, in a lot of ways. You’re going to pay taxes at the corporate tax rate, which is 21%.
And then you’re going to pay taxes on the dividend when it comes to you. And if you’re a successful orthodontist, that’s probably 23.8% federal. You add those two together, and you’re up in the 45% range or so. That’s not awesome. Better to just have the profits be paid to you and have you pay taxes at your tax rate, 32, 35, 37%, whatever it is, and just invest it on your own outside the business.
The other thing you bring up is like an asset protection thing. I don’t think putting the profits in your practice is really protecting them from the main source of your creditors, which is your practice. I’ve never heard of a doctor who was able to protect their assets because they said, “Oh no, no, I left that money in the practice.” Well, they’re probably suing your practice too. Not just you personally, but your practice too.
I don’t think there’s really any real asset protection benefit to doing that. And in fact, leaving that money in your business exposes it to the creditors of the business. The whole reason you formed an LLC or an S Corp was if that business gets sued, you can just give them everything the business owns, declare bankruptcy and keep your personal assets.
Now that doesn’t work for malpractice. Malpractice is always personal, but if there was a business deal that went sour or something and you ended up getting sued for it, well, at least all you would lose was the business if it’s an LLC or corporation.
And if that’s the case, “Why would you want to have any additional assets in that business?” It seems like it’d be worse asset protection to me than it would be if you just got that money out of the business and into your personal account, where it’s only exposed to your personal creditors, including malpractice creditors.
So, probably a bad idea. If you’re a C Corporation, you can consider it, but it’s probably still a bad idea even as a C Corporation. If the business does not need the money, get it out of the business.
The business does need the money. You probably don’t want it invested in stocks or something like that anyway. You probably want it to earn a decent yield on cash. You can open a business brokerage account and just keep it in a money market fund or some sort of high-yield savings account. So, that’s often harder to find as a business than it is as a person.
But if you need the cash in the business, why don’t you make a little interest on it while you’re there, but you want it to be a pretty safe investment. If it’s going to be in the business long-term, you’ve got to start asking yourself, maybe I don’t want it in the business, don’t you think?
SPONSOR
Dr. Jim Dahle:
This podcast was sponsored by Bob Bhayani at Protuity. One listener sent us this review. “Bob has been absolutely terrific to work with. Bob has quickly and clearly communicated with me by both email and or telephone with responses to my inquiries usually coming the same day. I have somewhat of a unique situation and Bob has been able to help explain the implications underwriting process in a clear and professional manner.”
Contact Bob at www.whitecoatinvestor.com/protuity. You can email [email protected], you can also call (973) 771-9100 and get your disability insurance in place today.
All right. Don’t forget about our private medical school loans partners. If you need private medical school loans, this is probably just for the first this year. I think the second, third, and fourth years are grandfathered in.
But guess what? You can only borrow $50,000 in federal loans this year if you’re a first year. If that’s not covering everything you need it to cover, you’re going to need some private loans. You can get those by going to whitecoatinvestor.com/loan.
Some of our lenders will give you cash back. If you get a loan through that link, we get paid obviously. This is how we make payroll. But we’re going to give you a free copy of the Fire Your Financial Advisor, the student version of the course to help you get started on your financial literacy journey right away.
Just for going through those links, it doesn’t cost you any more. And in fact, you get a little extra benefit by going through them. So, thank you for supporting the White Coat Investor by doing that.
Also, thanks for those of you who have been leaving Firestar reviews and telling friends about the podcast. A recent one said, “The Finance Guide for High Income Earners. Dr. Dali is able to guide new higher earners through their financial journey in a way that is honest, simple, and practical. He shows you that taking control of your own finances is empowering and simple. Such guidance is often overlooked by parents and school. This podcast is informative and valuable for new higher individuals/families.” Five stars. Thanks for sharing that. It does help get the word out.
All right. It’s summertime. I hope you have a great summer planned. If not, plan something great this summer. I don’t care if you’re still in residency or you’re starting an internship in a few weeks. Plan something cool this summer. Have some fun and maybe share it in one of our White Coat Investor online communities, the subreddit, the Facebook group, the WCI forum, or the FEW group.
Keep your head up, your shoulders back. You’ve got this. We’re here to help. See you next time on the White Coat Investor podcast.
DISCLAIMER
The White Coat Investor podcast is for your entertainment and information only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.
Milestones to Millionaire Transcript
Transcription – MtoM – 277
INTRODUCTION
This is the White Coat Investor podcast Milestones to Millionaire – Celebrating stories of success along the journey to financial freedom.
Dr. Jim Dahle:
This is Milestones to Millionaire podcast number 277.
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All right, welcome back to the podcast. This is a podcast where we feature you and your success to inspire the rest of the audience to do what you’ve done to accomplish their financial goals and to make one more step, one more milestone on the pathway to financial success. If you’d be interested in coming on this podcast, you can do that. Go to whitecoatinvestor.com/milestones to apply.
By the way, it is now summertime. So what does summer mean at White Coat Investor? It means it’s scholarship time. We do our scholarship contest every summer and we’re looking for judges to help select the winners for the scholarship. If you’d like to do that, email [email protected].
Now, there’s a few rules. You can’t be a student, you can’t be a resident and be a judge.You got to be an attending physician or a retired physician or something else. You don’t have to be a physician even, but you need to be out in your career or retired, et cetera. You can’t be still in training. Too much conflict of interest.
But we love our judges. We want to give this money away. We want to give these prizes away. We don’t want to have any of our own bias involved. So instead, we use all of your collective biases in order to choose who the winners are going to be.
And this is a beautiful program for a couple of reasons. One, it reduces the indebtedness directly of 10 students, which I think has value. We’ve been sending thousands of dollars. We literally just write them a check for 10 students every year for years. But it also, just the promotion of this scholarship program in each of their schools helps build financial literacy and financial discipline, helps them to know about the White Coat Investor and the resources available to them over the years.
We appreciate your support of this. You will be inspired as you read these scholarship applications. There are incredible people in medicine and similar careers. You will be thrilled to recognize. You will be re-inspired and reminded of why you went into it in the first place. So please volunteer to be a judge. Just email [email protected], put “Judge” in the title, and we’ll get you signed up.
Now, we don’t pay you to be a judge, but we don’t request too much work from you either. You do have to read some of their essays and help us choose the winners, but we’d love to have you along to help judge.
Now, for those of you who are students, not residents, residents can’t win this scholarship, but if you’re a student, you’re full-time, you’re in good standing, medical student, dental student, whatever, you can apply whitecoatinvestor.com/scholarship.
Now, obviously not everybody wins, but those who do get cash. We figure that’s going to reduce your indebtedness. That’s going to help you pay for school. That’s going to help you get to the other end of this long training tunnel that you’re in. We’re thankful for what you’re doing. We want to support you directly. This is mostly our way of giving back. Most of the money that comes, that pays for this scholarship is basically White Coat Investor profits. That’s what it is. It’s just our chance to give back to a community that has given us so much.
All right, we’ve got a great guest on today for the Milestones podcast. Let’s get him on.
INTERVIEW
Dr. Jim Dahle:
Our guest today on the Milestones to Millionaire podcast is Kennedy. Kennedy, welcome to the podcast.
Kennedy:
Thanks, Jim. It’s a thrill and an honor to be here.
Dr. Jim Dahle:
Introduce us a little bit to yourself. Where are you at in your training? What part of the country are you in? What’s going on with your financial life?
Kennedy:
Yeah, I’m an orthopedic surgery resident. I am in the military, as I’m sure we’ll get into in a little bit more detail, but I’m in my last year of residency, so graduating in just a couple months. And my program is located in San Diego.
Dr. Jim Dahle:
Okay, I think we’re going to drop this on June 1st, so you’ll be a month out from graduating from residency at that point. Tell us what milestone we’re celebrating here now in your final year of residency.
Kennedy:
Yeah, I guess the milestone itself is probably graduation, and it just so happens that that corresponds with my wife and I accumulating a net worth of a little north of $200,000.
Dr. Jim Dahle:
$200,000 before you’re even out of residency. That’s pretty awesome. Keep in mind, I don’t know that we have averages, but about three out of four doctors borrow to pay for school. That means that most of them are coming out with a negative net worth, and certainly it wouldn’t be unusual for a graduating resident to have a net worth of minus two hundred thousand dollars. That would not be unusual at all, and certainly we’ve seen people that have two or three times that much in negative net worth.
Meanwhile, you’re on the other side of the ledger. Not only do you not have a negative net worth, you have one that’s very positive. There’s plenty of doctors out there that have been out for a few years that don’t yet have a $200,000 net worth. So tell us the story. How’d you manage to do this?
Kennedy:
Yeah, again, like I mentioned, I’m a resident in the Navy, I think that is a huge part of it, pretty much all of it. Number one, they paid for my school, so no student loans. And number two there’s a little bit of a salary arbitrage between military residents versus civilian residents, and I recognized that early and knew I had to take advantage of it, and here we are.
Dr. Jim Dahle:
Okay, did you go to school on the HPSP program? Did you go to USUs? How did you do school?
Kennedy:
I was HPSP, yeah.
Dr. Jim Dahle:
HPSP. Essentially, you traded a year for a year of school, so you owe the military. What do you owe them now, four years, or do you owe them five for the five-year residency?
Kennedy:
I’ll owe them four years. Engineer’s a wash, I guess.
Dr. Jim Dahle:
Engineer’s a wash, so the other four years count. Okay, so they paid for what? What was your stipend when you were in school? This has been five years ago since you got that, but what was your stipend when you were in school?
Kennedy:
It was about $2,100 a month.
Dr. Jim Dahle:
Well, it seems like a lot. I only got like $800 something.
Kennedy:
Yeah, yeah.
Dr. Jim Dahle:
Maybe it was $900-something by the time I got out.
Kennedy:
It was certainly plenty to live off of, we weren’t gaining any ground during that time, but at least breaking even.
Dr. Jim Dahle:
Okay, $2,100 a month you’re getting to spend on whatever, and then they’re covering what? They’re covering your tuition, your fees, they bought some equipment for you, they bought all your books, they pay for health insurance for you?
Kennedy:
Yeah, all that is covered.
Dr. Jim Dahle:
Okay, did you feel like that was enough? Did you feel like I really could have used some more money? If I’d had some student loans available to me, I would have taken out some additional loans, or was that enough?
Kennedy:
That was plenty for me. A little bit more background. I’m from Wisconsin, Milwaukee specifically, and that’s where I did all my schooling. So, a relatively low cost of living area. I think my rent throughout med school was somewhere between $800 to $1,000 a month, and then had the rest of that stipend to spend on other living expenses, which was plenty.
Dr. Jim Dahle:
Now, you’re using a plural pronoun at times. Is there somebody else in this family we should know about?
Kennedy:
Yeah, I am married. We’ve celebrated our five-year anniversary on paper.
Dr. Jim Dahle:
Congratulations.
Kennedy:
We’ll be celebrating our ceremonial anniversary next month, and we have two kids as well, who are both pretty young.
Dr. Jim Dahle:
Some other people have been along for this journey. Is your spouse working?
Kennedy:
She currently is not. She was for the first two years of residency until we had our son.
Dr. Jim Dahle:
Okay, was she working while you were in school?
Kennedy:
She was.
Dr. Jim Dahle:
But you guys weren’t necessarily together then, because you’d only been together five years. Okay, very cool. All right, you didn’t invest all this money while you were in school. Half of it was going toward rent, and the other half, I presume, you were using to eat mostly. What was your net worth when you came out of school?
Kennedy:
Net worth was probably just about even. I did accumulate a little over $20,000 of undergrad loans that I’m actually still paying off, and then just had a little bit of cash on hand. At the end of med school, it was just about break-even.
Dr. Jim Dahle:
You’re break-even coming out of medical school. Tell us what your salary has been during your residency program in the Navy.
Kennedy:
My salary has steadily increased throughout the years, which is great. As you know from your time in the military, there’s a little bit of, I guess, adjustment in your pay based on where you live in terms of your housing allowance. Living in San Diego, pretty high cost of living. So my salary has ranged from about $90,000 when I was an intern up to this year’s probably, simply put, about $140,000.
Dr. Jim Dahle:
Okay, $90,000 to $140,000 as a resident, which sounds awesome to everybody out there making $65,000 and sounds incredible to me who signed a contract for $34,000, which tells you how old I am. But okay, did you moonlight at all during those five years?
Kennedy:
No, we are not allowed to.
Dr. Jim Dahle:
Not allowed to, so it wasn’t an option. All right, they figure if you can’t live on $90,000 to $140,000, you’re just out of luck. Basically for the last five years, you’ve made $100,000 a year or so. You made about $500,000 and you’ve got about $200,000 of it left, which is pretty awesome. Tell us how you did that while living in San Diego.
Kennedy:
I think the main thing is we did the first couple years take advantage of the high housing stipend and we lived in a lower cost apartment for a while to be able to save some extra money that way.
The biggest thing has been taking advantage of the TSP or the government 401(k) program. I knew coming in that I just wanted to max that out right away, never even see that money and also collect a match. And that’s where a majority of our assets are right now.
Dr. Jim Dahle:
Yeah, it’s pretty awesome to get that match, isn’t it? Yeah, it wasn’t available to me. Pretty awesome to have a Roth TSP account too, isn’t it?
Kennedy:
Absolutely.
Dr. Jim Dahle:
Yeah, that wasn’t available for me either. So very cool. And I assume most of this is going on the Roth side?
Kennedy:
Yeah, all of it. And then as you know, they just started allowing for a Roth conversion. All of the match money goes into a traditional account, but I did just initiate transfer of all that into Roth, or I guess converting, I should say.
Dr. Jim Dahle:
That’s going to make it easier when you get deployed and get some tax-free deployment pay in there, you can just convert all that as well. The fact that you don’t have any tax deferred TSP money. I think you’ll be really happy about that. All right. How have you invested that TSP money? What’s it been invested in?
Kennedy:
It is currently 100% in stocks. And that’s a combination of the C fund, the S fund and the I fund, which is total stock market, small market, a little bit of a tilt there, and then the international market funds.
Dr. Jim Dahle:
Very cool. Okay. Advice for others. There are people out there that are considering the HPSP program, and I would describe you as having received all the benefits right now, and very few of the downsides. You didn’t have to go through the military match, which is not insignificant so far, but you haven’t seen the lower paychecks you typically get as a military doc. You haven’t seen any deployments yet. You’ve had all the upsides. What would you talk to somebody considering the HPSP program? What would you tell them? They’re like, “Should I have military pay for my medical school?”
Kennedy:
Yeah. I think you on this podcast and in your blog posts as well, several guests have just really described how I would not do this program for the financial benefits alone. You really got to do some soul searching and figure out if this is right for you. Like you mentioned, my pay, once I graduate will be significantly less than my civilian counterparts. I do think that it will even out or eventually I’ll be in the hole compared to if I did this all basically my own way.
But I do think if serving your country is something that’s important to you or you’re okay with receiving a little bit lower salary as an attending physician for a while, it’s a great way to get school paid for.
Dr. Jim Dahle:
To be fair, this works out just fine for a lot of specialties. If you’re in pediatrics or preventive medicine or family practice, you don’t get paid that much less than the military in this civilian world. Ortho, obviously there’s a big difference because orthopedists tend to make lots of money. But what would you expect to make next year, your first full year as a military attending orthopedic surgeon with still in payback? What do you expect your total income to be next year?
Kennedy:
My total income is going to be right about $190,000.
Dr. Jim Dahle:
And if you look at salary surveys for the average orthopedic surgeon, you’ll see it’s more like something like half a million. So there’s a big difference between half a million and $190,000. You can pay a lot of student loans off with that. And I think that’s a good demonstration of exactly what you said, which is this probably isn’t something you do primarily for the financial reasons. It’s for a desire to serve and some of the unique things that you can only do in the military.
But the beautiful thing about it is it’s much more of a traditional career and financial path in that you don’t have the classic doctor path where you’re in this massive debt when you start, and then you don’t get paid all that much in residency. And so, you start your life minus $300,000. Instead, you’re starting your life $200,000 on the plus side. So you’ve already got money working for you, not to mention all the tax benefits of military service.
What advice do you have now for somebody that’s already say they’re in the HPSP program or they’re attending USUs or they’re in a residency program now, whether they’re deferred to a civilian residency or whether they’re in a military residency? What advice do you have to them to make sure they take advantage of those early financial advantages that you get by going the military route so they can make up for the later financial disadvantage of being paid a little bit less while you’re in payback?
Kennedy:
Yeah, I think, again, just recognizing that we are paid pretty well in the military as residents. And particularly if you’re going USUs, you’re on salary while you’re in school, which is incredible. But take advantage of that because these are still going to be relatively low cost of living times of your life. As residents, we’re super busy, which stinks because we don’t have any free time to ourselves. But that also means we’re not out there spending money because we don’t have any time to do so.
But get your financial ducks in a row. I would highly encourage anybody to go through your site, read your books, get something of a financial plan in place just so that it’s all kind of automated when you do get into residency to just, again, like you said, accumulate a little bit of investments and let your money start working for you as early on as possible.
Dr. Jim Dahle:
Well, the military, it’s not just everything in life isn’t about finances. Talk to us a little bit about what going the military route for training has meant to your family from a non-financial perspective.
Kennedy:
When I joined, I was single. It was just me. This sounded like a great opportunity to travel the world while practicing medicine, which is what I knew I always wanted to do. Now with a wife and kids, I’m more concerned about the potential for deployment and the negative aspects of being told when and where we’re going to be moving for our next duty station, that kind of thing.
Those are certainly things to be mindful of going into this. I think one thing that I’ve really grown to appreciate going through medical school, and I’m sure you can attest to this, is just how much your life changes from when you start this training pipeline to when you eventually get out of it.
Dr. Jim Dahle:
Yeah, it’s hard to know at 25 what’s going to make you happy at 35, isn’t it?
Kennedy:
Yeah, for sure. And just where your life is going to be at. If I may, on the positive side it’s offered chances for my family to live in areas that we probably wouldn’t have otherwise considered living. Like San Diego, I don’t think we ever would imagine coming here if it wasn’t for the military. And next year we’re actually going to Jacksonville, Florida. So we’re kind of hitting all corners of the country.
Dr. Jim Dahle:
Two places that are very different from Wisconsin.
Kennedy:
Yeah.
Dr. Jim Dahle:
Tell us a little bit about your upbringing and your journey to financial awakening.
Kennedy:
I grew up, like you mentioned, in Wisconsin. I was the oldest of four kids. My dad was actually a financial advisor by profession. My parents did instill in me pretty early on the importance of saving as I got a little older, the importance of what credit cards are actually supposed to be used for and that kind of thing. My dad did give me some lessons early on about what he does, just having your money work for you, which I do carry with me, obviously, to this day and have since built upon.
I remember the first time he told me what he does. He’s like, “Yeah, I take people’s money and I put it in places and it grows.” And I literally thought he took a lot of cash, put it in a file cabinet drawer or something, opened it up a couple of years later in the stack of cash crew. And I was like, “Well, let’s do that for me.”
Obviously, I’ve grown a little since then, but those lessons early on really helped instill in me some self-discipline. And then beyond the financial aspects, they strongly encouraged just great life virtues, hard work, humility, being kind to others. And I think that also kind of translates to financial behavior as well.
Dr. Jim Dahle:
So, you come from a different place than a lot of people. A lot of people, they are the first doctor in their family or whatever, and no one ever taught them about finances. They were just signed up for monopoly money when they go to medical school and take out these loans. And it’s kind of a rude awakening when they first realized, I don’t know anything about money.
Did you feel like you’d been given as much of an advantage as you should have been, given your dad’s profession? Or do you feel like there was maybe more that he could have taught you? And if so, what would you have liked to learn before you left home?
Kennedy:
Oh, that’s a good question. As I’ve gone on and gotten more financially literate myself, I have noticed there have been probably some gaps that I feel like he could have taught me some more specifics about, at least. I would say my financial awakening really happened during undergrad. I got a minor in business, just for the sake of at least getting some kind of grasp on how businesses run.
And honestly, one of my favorite classes from undergrad was finance 101. We had a super passionate professor who taught us about time value of money calculations and all that. I’m convinced that his curriculum was based on the book “A Random Walk Down Wall Street.”
After that course finished, I picked up that book. And that’s when I really, I think, started to learn about how simple investing can be and general approaches to investing. And then that sort of snowballed into med school. I stumbled across a bunch of other financial books as well as yours. And that really was the springboard for me feeling comfortable managing my own finances.
Dr. Jim Dahle:
Pretty awesome. All right. Talk to us about some of your future financial goals. What else do you want to accomplish financially?
Kennedy:
Yeah, I guess short term, my lofty goal is to hopefully be a millionaire by the time that I get out of military service, which will be in about four years, like we mentioned.
Dr. Jim Dahle:
Very cool. Well, I wish you the best of luck on that. And hopefully we’ll have you back on here for another episode in about four years and celebrate that with you. Thank you so much for being willing to serve. I hope any deployments you may be assigned to go well and that you wish you safety as well as a sense of purpose as you go about your work and a great deal of camaraderie as you work with the teams you’ll be assigned to work with. Thank you so much for being willing to come on the podcast and share your story with others.
Kennedy:
Yeah, thanks, Jim. I appreciate being here.
Dr. Jim Dahle:
I’m so grateful for those of you out there in the military. Those of you in some sort of public service like that, thank you so much. I know a lot of times it means you’re actually making less money than you would be otherwise. And I’m grateful that there’s some benefits that lessen that impact, whether that’s public service loan forgiveness or loan payback programs or things like the HPSP program or USUs or some of the tax benefits you get from being in the military. It’s nice to soften that blow a little bit.
But particularly those who go into relatively highly paid specialties in the military, they’re not coming out ahead to do this. They need to take advantage of what advantages they do have. The money you make in medical school and then increased income you have during residency to make up for part of that lower income later.
Now, it’s nice you don’t pay nearly as much in taxes. But at the end of the day, if you have more after you pay the taxes, that’s a little bit more of an advantage, for sure.
FINANCIAL BOOT CAMP: TARGET DATE FUNDS
Tyler Scott:
Hello, my name is Tyler Scott with White Coat Planning. And Dr. Dahle has asked me to come share a principle with you today. I’m excited to talk about target date funds. Target date funds are the ultimate in “set it and forget it” investing because they do three really useful things for us that require no additional work or management on our part.
First, they give us an appropriate asset allocation for our age. By asset allocation, I mean our mix of stocks and bonds. For example, I’m 40 years old. I invest in the 2050 target date fund in my Vanguard 401(k). The year 2050 is about the year that I’ll turn 65. The fund knows I’m roughly 40 years old. And thus it gives me an asset allocation of about 90% stocks and 10% bonds. About two thirds of the stock are US and the other third are international. I get a very reasonable, highly diversified, low cost mix of US and international stocks and bonds that’s appropriate for my age.
The second thing target date funds do for us is adjust our asset allocation automatically as we age. It’s one thing to have a 90/10 stock to bond portfolio at age 40. It’s an entirely different thing to roll with that aggressive of a portfolio at age 60.
At 40 years old, I don’t care at all if the stock market loses half of its value tomorrow morning, because I’m more than 20 years away from needing those assets. In fact, perversely and selfishly, I want the market to do bad, so that all those juicy stocks I want to buy go on sale anyways. The stock market crash for a young person is synonymous with Black Friday after Thanksgiving. It’s the sale we’ve been dreaming of.
However, I do not want to wake up on my 65th birthday to see that half of my lifetime savings has disappeared in a stock market crash. In order to mitigate against this, we want to shift our asset allocation slowly and deliberately as we age. So, we drop from holding 90% highly volatile stocks to more like 50 or 60% stocks with a corresponding increase to 40 or 50% of more stably priced bonds. That way, if a stock market crash occurs in my 60s, I might see a decrease of 10% of my portfolio, not 30 or 40%.
Well, you can adjust your asset allocation manually over the years if you’re confident in managing your own portfolio, or you can just choose a target date fund to do it for you. Each year I get closer to the year 2050, the fund slowly ratchets up the percentage of bonds that I own. I don’t have to do anything.
This concept of adjusting your asset allocation over time is known as a glide path. We glide from a 90-10 portfolio to a 60-40 portfolio as we age. A target date fund will follow the glide path for you.
The final way a target date fund aids us in setting it and forgetting it is that it automatically rebalances itself through the year. What I mean by rebalancing is that we want to maintain our desired percentage of assets at all times. Let’s say that the desired percentage is 60% stock for U.S., 30% stock internationally, and 10% U.S. bonds.
If you purchased three individual index funds in those relative percentages, they would stay at your desired ratio for a pretty short period of time in most cases. That’s because the U.S. bond market and the international stock market do not have perfect correlation with one another. They rise and fall at different rates, and that’s a good thing. That’s the diversification that we want.
The problem is that if the international economy goes on a tear and the U.S. bond market has a terrible year, then you don’t have 30% international stocks and 10% U.S. bonds anymore. You might have something like 35% international stocks and 5% U.S. bonds. That’s not the asset allocation you want. That’s the wrong balance of your funds. So you have to go into the account and rebalance by selling some portion of the overperforming asset and buying the underperforming one until you achieve your desired balance again.
Well, a target date fund rebalances itself regularly every month or every quarter. You don’t ever have to go into the account and buy and sell anything. That’s what makes target date funds awesome. They give you a rational asset allocation. They follow a rational glide path and they rebalance at a rational interval.
Now that I’ve got you hopefully pumped up on the glory of target date funds, let’s talk about some important nuances. First, there can be a terminology trap here. These funds are also known as target retirement funds because the date you are often picking is allegedly your retirement date. But I actually hate that term of target retirement funds and do not recommend thinking of your retirement timeline at all when choosing a target date fund to use.
The reason for that is some people will retire at age 45, some at 55, some at 75. This retirement timeline should not really be our primary concern when it comes to the longevity of our nest egg. Rather, the point of “retirement” savings is to make sure we don’t run out of money before we die. When we die has nothing to do with when we retire.
In financial planning, we do our math to create a nest egg to support us until age 95. I very well may retire in 2040, but I will always use a 2050 target date fund because the year 2050 is when I turn 65. I think these should be called target 65th birthday funds. That would be more clear and aligned with their intended purpose.
This brings us to another question I see clients wrestle with. Let’s say one spouse is age 40 and the other is age 30. Which target date fund should the household use? The answer is to take the average age of the couple. In our example, the couple should think of themselves as 35 years old collectively, and maybe they would use a 2055 target date fund.
I think that is the simplest way to think about it. Otherwise, it becomes very difficult to know and to manage the overall asset allocation of the family if one spouse has X dollars in one target date fund and the other spouse has Y dollars in a different target date fund.
Another wrinkle with target date funds relates to risk tolerance. Occasionally, I’ll get a client that says, “Well, yeah, Tyler, I totally get it, but I want to take more or less risk than this glide path will take me on. So maybe a target date fund is not the right thing for me.”
To that I say, just pick a slightly different target date fund. If you’re 40 years old and that would correlate to the 2050 fund, like I’ve talked about, and you want to take more risk, great. Pick the 2055 or 2060 target date fund instead, which will keep more of your assets in stocks for a longer period of time. Conversely, if you want to take less risk, maybe you pick the 2045 or 2040 fund that will have more bonds now and shift you away from stocks faster as the years go by.
One thing to be mindful of with target date funds is they are not all created equal. Some are awesome and some are awful. You really have to look under the hood and understand what the funds in the target date fund are actually using and buying to create the underlying asset allocation.
And most importantly, you want to pay attention to what the fees are. The fees are often expressed as an expense ratio. And that’s a term I have described in a different one of these videos. But basically an expense ratio is a fee to you that you pay the firm who has created the investment. It’s expressed as a percentage of the total dollars you have in that investment.
If the expense ratio is 1%, you must pay 1% of your total holdings to the investment company each year. Expense ratios are important to pay attention to. They erode your wealth. You want to keep them low. Some target date funds like the ones at Vanguard have very low expense ratios. The 2050 fund I use has an annual fee of 0.08%. So eight one hundredths of a percent. That’s pretty awesome. So if I have $100,000 in the fund, I pay $80 a year to have the benefit of using the target date fund. That’s a pretty dang good deal for a fund that guarantees a good asset allocation, follows a good glide path and automatically rebalances.
Some target date funds have terrible expense ratios like 0.75% or all the way up to 2%. Let’s say you had one that was 1.5%. Now, if you’ve got $100,000 in there, you have to pay $1,500 a year for the benefits of the target date fund. If you have a million dollars in there, you have to pay $15,000 every year and it goes up each year as the account grows.
That is not a good deal. Don’t do that. Find a lower cost alternative. Maybe that’s individual funds and then you have to manage the account yourself or find a financial planner to help you do it. I do this all the time with clients. I tell them to stop using really awful target date funds and teach them how to adjust the asset allocation themselves so they don’t waste thousands of dollars in some crappy target date fund each year.
Big brokerages like Vanguard, Fidelity and Schwab typically have good low cost target date funds. Another thing I like about target date funds is the ease when it comes to estate planning. I could follow my own glide path and rebalance my own accounts. I’m a finance nerd. I love this stuff. My wife, she is not a finance nerd and she barely tolerates this level of detail. She decidedly does not want to create and follow a glide path with any kind of quarterly rebalancing.
Even though this is my professional field, I use target date funds in almost all of our accounts because if I die, no one needs to do anything. Nothing needs to be changed. The investments will just roll forward on a good track into the future forever. Awesome.
My closing thought after all that hype about target date funds is do not use them in your taxable brokerage account. For myriad technical reasons that transcend this intro lesson, just know that they are not typically a smart choice in your taxable brokerage account. They’re awesome in tax protected accounts like 401(k)s, 403(b)s, 457s, HSAs, IRAs, also in 529s for your college savings. Often we call them target enrollment funds with the target year being the year the child finishes high school or starts college. Just don’t use them in a taxable account.
They’re nearly ubiquitous in employer retirement accounts these days, which is good, except for the ones that are awful. So watch out for those. They’re almost always available in your HSAs and definitely in your IRAs as long as you’re with Vanguard, Fidelity, Schwab. Target date funds are pretty cool. Give them a long look. If you’re maximum simplicity and low stress, they are the ultimate and set it and forget it investing.
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All right, head up, shoulders back. You’ve got this. We’re here to help. See you next time on the Milestones to Millionaire podcast.
DISCLAIMER
The White Coat Investor podcast is for your entertainment and information only. It should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.
Financial Boot Camp Transcript
Dr. Jim Dahle:
This is the White Coat Investor Podcast, Financial Boot Camp, your fast track to financial success.
An index fund is a type of mutual fund that, instead of trying to beat the market, just tries to match the market. A mutual fund’s a great way to invest, right? You get economies of scale, you get professional management, you get daily liquidity, you get broad diversification with only having to buy one investment. They’re wonderful, but there’s two types, right? There’s the type that’s actively managed, trying to beat the market. There’s the type that is passively managed, or just trying to match the market, or the index, and it turns out in the long run that just matching the market beats most investors, because most investors, including most professional investors, including most actively managed mutual funds, do not beat the index in the long term, and that’s before taxes. Once you add in the effective taxes, even more funds underperform index funds, so index fund investors tend to acknowledge that I’m better off just taking the guarantee that I’m going to beat the vast majority of investors, even if I’m not going to, you know, beat all of them, or I’m not going to outperform the index. Those returns are going to be good enough for me to reach my financial goals.
Now, index funds can be traditional mutual funds, they can also be exchange traded funds, right? They’re just two different types of mutual funds, really. And index funds can use either type, but they differ from actively managed funds. And actively managed funds can also be traditional mutual funds or exchange traded funds. So, you know, it’s not index funds and ETFs, it’s not index funds and mutual funds. Index funds are a subcategory of both mutual funds and ETFs.
Okay, the indices, these indexes, or whatever you want to say the plural of that is, are created by index providers. Okay, so there are classic ones, right, that have been around for decades and decades, like the Dow Jones Industrial Average, right, or the S and P 500. There are others, the Russell 2000. There are all these different kinds of indexes, and they were produced for different reasons historically. These days, many of them are produced so the index funds can be used that follow them, so you got to be a little bit careful, right?
When I’m talking about index funds, I’m generally talking about pretty broad-based index funds, right? Things like the total stock market index fund that tries to track all of the US stocks. You know, that fund might have 3,800 different stocks in it, whereas there’s probably an index fund out there that just follows, you know, kitchen stove makers, you know, that sort of a thing, whereas a very narrow index, and thus a very narrow and non-diversified fund. When I’m talking about investing in index funds, those are not the type of ones I’m talking about. I’m talking about the broad-based ones.
Now, so maybe you want to put a slice of your portfolio into real estate or something, and you want an index fund that focuses on those real estate companies in the stock market, and I think that’s fine, but recognize that there are indexes out there that are not very broad at all, and that’s not what we’re talking about when we’re saying most people should invest most of their money into index funds. We’re talking about buying all the stocks as a strategy, recognizing that yes, you’ll own the losers, but you’re going to own every single one of the winners, and over the long run, it’s going to get you the market return, and that’s going to get you to your financial goals.
Part of the reason why these index funds outperform active funds is because they have low costs, right? It isn’t that it’s impossible to beat the market, it’s just that it costs a lot of money to beat the market. You got to hire all these analysts, you got to send them out to research these companies and talk to these people working these companies and do all this research and have all these high-powered computing resources, right? And it turns out when you add in the costs of doing that, you can’t outperform by enough to cover your costs, and that’s not because these people aren’t smart, they are smart, there’s just too many smart people, and so at the end of the day, the market is the compilation of all these smart people and their opinions about what stocks are worth.
And so the index fund investors are essentially free riding all these people trying to beat the market, and all the effort they’re putting in to try to make sure stocks are priced appropriately, or to buy them if they’re maybe a little too underpriced, or to sell them if a little too overpriced, and that makes the market efficient enough, not perfectly efficient, but efficient enough that the right thing to do as an investor is to act as though the market is perfectly efficient. The way you do that is just by buying all the stocks within index funds, and it turns out that this is relatively easy to do.
Right, it’s not hard to match the market. I mean, there is some expertise involved in it, you know, there’s computing resources, and if you talk to the people who run these big index funds at Vanguard, or wherever, there’s a little bit of nuance to doing it, but the bottom line is it’s dramatically less expensive than running an actively managed mutual fund, and so the expense ratios on these funds can be very low.
Now, it’s not unusual to see them at 0.03% or three basis points, they might be five basis points, or 10, or 15 basis points. A few of them at Fidelity are even zero basis points, but the point is, when you’ve gotten your expenses for running that fund down below about 15 basis points, it’s essentially free, right? Investing is free, you can buy every stock in the world in 30 seconds for free, right? Essentially free, right. And so that’s why index funds are so inexpensive, because it just doesn’t take that much in resources to match the market, especially as the fund gets really big, and you get all these economies of scale.
Now, fees do matter, right? They matter over a long investing lifetime. You’ve heard about compounding your returns, where you also compound your costs over time, and a lot of people talk about, you know, 1%. One percent is like what the average mutual fund charges. One percent is what a typical financial advisor charges, and over the course of 30 years that adds up to having about a third less money than you would otherwise have if you were investing for free, so fees do matter. The only place they can come out of is your return, right?
And fees, when it comes to a mutual fund, like an index fund, are generally expressed as an expense ratio, right? So, of the assets in the fund, what percentage of them was spent on running the fund this year, and that definitely ought to be less than 1%. It probably should be less than 0.1% when it comes to an index fund, but that’s what the expense ratio is.
I mentioned taxes earlier. Index funds are generally considered more tax efficient than actively managed mutual funds, and that’s simply an effect of the turnover, right? Because you’re just trying to track the index, you’re not trying to beat it, so you’re not constantly buying and selling different stocks. Well, when you do that, you generate capital gains, and by law, those capital gains have to be distributed to the investors in the mutual fund every year.
So, if you’re an actively managed fund with 60% or 90% or 150% turnover every year, you’re going to send out a lot of capital gains to those investors, and they’re going to have to pay taxes on them. They’re going to have lower after-tax returns, whereas if your turnover is 3% like is often seen in something like the total stock market index fund, they don’t have to distribute hardly any capital gains to you, and might not distribute capital gains for literally years or even decades, and so it’s very tax efficient compared to active funds, and that makes it even harder for these active managers to beat the index funds in the long run on an after-tax basis when you’re investing inside a taxable account.
Sometimes people wonder if there’s a point in which you have so much wealth that you need to do something different than index funds, and the truth is, you don’t. You can invest, you know, $50,000 or $500,000 or $5 million or $50 million into a total stock market index fund, and it works about the same, right? You know, you can do it with $500 or $1,000 right? Whatever the minimum might be for that particular fund. With ETFs, the minimum is usually just one share price, whatever the price of one share might be.
And so there really is not a time when you have to stop investing in index funds and you have to do something more complicated, or go into private investments. Now, sometimes there’s a role for some of that stuff in a portfolio, and that’s okay. And oftentimes it only makes sense to consider those things once you reach a certain level of wealth, but you don’t have to stop using index funds. Even at our current level of wealth, I still have the vast majority of our money invested in boring old index funds.
Some people worry that indexing is getting too popular, and that could create problems when everybody’s indexing. Well, now the market’s not efficient, stocks aren’t priced properly, and now we’re running up the prices of, you know, the popular stocks way too much. Well, I suppose that is a risk if everybody is indexing, but the truth is, you can have the vast majority of people be indexing. You don’t need that many active managers to make indexing the right thing to do. You just need enough that the market remains efficient enough that the right move is to just buy the market.
And so I wouldn’t worry about indexing being too popular until certainly upwards of 90% or 95% or maybe even 99% of the money in the market is indexed, because there’s still going to be plenty of opportunists and entrepreneurs out there trying to make a buck by finding stocks that are not properly priced by the market that they will move those prices to where they ought to be and make indexing the right move.
So don’t make the mistake that lots of investors do, and abandon index funds, thinking that actively managed mutual funds are better in bull markets, or better in bear markets, or better once you have a certain amount of money. It is just not the case, right? The data is very robust that index funds outperform traditional actively managed mutual funds, so don’t be afraid to invest in them, and you probably ought to be investing the vast majority of your stock investments into index mutual funds.
Hope that helps you understand the benefits of index funds and what they are.
The White Coat Investor Podcast is for your entertainment and information only, and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.
